UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
(Mark
One)
x
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the
fiscal year
ended
DECEMBER 31,
2008
Or
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the
transition period from _________________________ to
_________________________________
Commission
file number
001-11252
Hallmark
Financial Services, Inc.
(Exact
name of registrant as specified in its charter)
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Nevada
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87-0447375
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(State
or Other Jurisdiction of Incorporation or Organization)
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(I.R.S.
Employer Identification No.)
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777
Main Street, Suite 1000, Fort Worth, Texas
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76102
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(Address
of Principal Executive Offices)
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(Zip
Code)
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Registrant's
Telephone Number, Including Area Code:
(817) 348-1600
Securities
registered pursuant to Section 12(b) of the Act:
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Title of Each Class
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Name of Each Exchange on Which
Registered
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Common
Stock $.18 par value
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Nasdaq
Global Market
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Securities
registered pursuant to Section 12(g) of the Act:
None
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes
¨
No
x
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes
¨
No
x
Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90
days. Yes
x
No
¨
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of the registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting
company. See definition of “accelerated filer”, “large
accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act. (Check one):
Large
accelerated filer
¨
Accelerated
filer
¨
Non-accelerated
filer
¨
Smaller
reporting company
x
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange
Act). Yes
¨
No
x
State the
aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the common equity was
last sold, or the average bid and asked price of such common equity, as of the
last business day of the registrant’s most recently completed second fiscal
quarter. $57,096,612
Indicate
the number of shares outstanding of each of the registrant's classes of common
stock, as of the latest practicable date. 20,863,670 shares of common
stock, $.18 par value per share, outstanding as of March 20,
2009.
DOCUMENTS
INCORPORATED BY REFERENCE
The
information required by Part III is incorporated by reference from the
Registrant's definitive proxy statement to be filed with the Commission pursuant
to Regulation 14A not later than 120 days after the end of the fiscal year
covered by this report.
Unless
the context requires otherwise, in this Form 10-K the term “Hallmark” refers
solely to Hallmark Financial Services, Inc. and the terms “we,” “our,” and “us”
refer to Hallmark and its subsidiaries. The direct and indirect
subsidiaries of Hallmark are referred to in this Form 10-K in the
manner identified in the chart under “Item 1. Business – Operational
Structure.”
Risks Associated with
Forward-Looking Statements Included in this Form 10-K
This Form
10-K contains certain forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995, which are intended to be
covered by the safe harbors created thereby. Forward-looking
statements include statements which are predictive in nature, which depend upon
or refer to future events or conditions, or which include words such as
“expect,” “anticipate,” “intend,” “plan,” “believe,” “estimate” or similar
expressions. These statements include the plans and objectives of
management for future operations, including plans and objectives relating to
future growth of our business activities and availability of
funds. Statements regarding the following subjects are
forward-looking by their nature:
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our
business and growth strategies;
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our
performance goals;
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our
projected financial condition and operating
results;
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our
understanding of our competition;
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industry
and market trends;
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the
impact of technology on our products, operations and business;
and
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any
other statements or assumptions that are not historical
facts.
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The
forward-looking statements included in this Form 10-K are based on current
expectations that involve numerous risks and
uncertainties. Assumptions relating to these forward-looking
statements involve judgments with respect to, among other things, future
economic, competitive and market conditions, legislative initiatives, regulatory
framework, weather-related events and future business decisions, all of which
are difficult or impossible to predict accurately and many of which are beyond
our control. Although we believe that the assumptions underlying
these forward-looking statements are reasonable, any of the assumptions could be
inaccurate and, therefore, there can be no assurance that the forward-looking
statements included in this Form 10-K will prove to be accurate. In
light of the significant uncertainties inherent in these forward-looking
statements, the inclusion of such information should not be regarded as a
representation that our objectives and plans will be achieved.
PART
I
Item
1. Business.
Who
We Are
We are a
diversified property/casualty insurance group that serves businesses and
individuals in specialty and niche markets. We offer standard
commercial insurance, specialty commercial insurance and personal insurance in
selected market subcategories that are characteristically low-severity and
short-tailed risks. We focus on marketing, distributing, underwriting
and servicing property/casualty insurance products that require specialized
underwriting expertise or market knowledge. We believe this approach
provides us the best opportunity to achieve favorable policy terms and
pricing. The insurance policies we produce are written by our three
insurance company subsidiaries as well as unaffiliated insurers.
We
market, distribute, underwrite and service our property/casualty insurance
products through five operating units, each of which has a specific
focus. Our AHIS Operating Unit (formerly known as HGA Operating
Unit) primarily handles standard commercial insurance, our TGA Operating Unit
concentrates on excess and surplus lines commercial insurance, our Aerospace
Operating Unit specializes in general aviation insurance, our Heath XS Operating
Unit handles excess commercial automobile and commercial umbrella risks on both
an admitted and non-admitted basis and our Personal Lines Operating Unit
(formerly known as Phoenix Operating Unit) focuses on non-standard personal
automobile insurance. The subsidiaries comprising our TGA Operating
Unit and our Aerospace Operating Unit were acquired effective January 1,
2006. The subsidiaries comprising our Heath XS Operating Unit were
acquired effective August 29, 2008.
Each
operating unit has its own management team with significant experience in
distributing products to its target markets and proven success in achieving
underwriting profitability and providing efficient claims
management. Each operating unit is responsible for marketing,
distribution, underwriting and claims management while we provide capital
management, reinsurance, actuarial, investment, financial reporting, technology
and legal services and back office support at the parent
level. We believe this approach optimizes our operating results
by allowing us to effectively penetrate our selected specialty and niche markets
while maintaining operational controls, managing risks, controlling overhead and
efficiently allocating our capital across operating units.
We expect
future growth to be derived from increased retention of the premiums we write,
organic growth in the premium production of our existing operating units and
selected, opportunistic acquisitions that meet our criteria. For the
year ended December 31, 2008, approximately 82% of the total premium we produced
was retained by our insurance company subsidiaries, while the remaining 18% was
written for or ceded to unaffiliated insurers. We expect to continue to increase
our retention of the total premium we produce. We believe increasing
our overall retention will drive greater near-term profitability than focusing
solely on growth in premium production and market share.
What
We Do
We market
standard commercial, specialty commercial and personal property/casualty
insurance products which are tailored to the risks and coverages required by the
insured. We believe that most of our target markets are underserved
by larger property/casualty underwriters because of the specialized nature of
the underwriting required. We are able to offer these products
profitably as a result of the expertise of our experienced
underwriters. We also believe our long-standing relationships with
independent general agencies and retail agents and the service we provide
differentiate us from larger property/casualty underwriters.
Our AHIS
Operating Unit primarily underwrites low-severity, short-tailed commercial
property/casualty insurance products in the standard market. These
products have historically produced stable loss results and include general
liability, commercial automobile, commercial property and umbrella
coverages. Our AHIS Operating Unit currently markets its products
through a network of approximately 230 independent agents primarily serving
businesses in the non-urban areas of Texas, New Mexico, Oregon, Idaho, Montana,
Washington, Utah, and Wyoming.
Our TGA
Operating Unit primarily offers commercial property/casualty insurance products
in the excess and surplus lines market. Excess and surplus lines
insurance provides coverage for difficult to place risks that do not fit the
underwriting criteria of insurers operating in the standard
market. Our TGA Operating Unit focuses on small- to medium-sized
commercial businesses that do not meet the underwriting requirements of standard
insurers due to factors such as loss history, number of years in business,
minimum premium size and types of business operation. Our TGA
Operating Unit primarily writes general liability, commercial automobile and
commercial property policies. Our TGA Operating Unit markets its
products through 39 independent general agencies with offices in Texas,
Louisiana, Oklahoma and Arkansas, as well as 768 independent retail
agents.
Our
Aerospace Operating Unit offers general aviation property/casualty insurance
primarily for private and small commercial aircraft and
airports. The aircraft liability and hull insurance products
underwritten by our Aerospace Operating Unit are targeted to transitional or
non-standard pilots who may have difficulty obtaining insurance from a standard
carrier. Airport liability insurance is marketed to smaller, regional
airports. Our Aerospace Operating Unit markets these general aviation
insurance products through approximately 200 independent specialty brokers in 48
states.
Our Heath
XS Operating Unit offers small and middle market excess commercial automobile
and commercial umbrella risks on both an admitted and non-admitted basis
focusing exclusively on trucking, specialty automobile, and non-fleet automobile
coverage. Typical risks range from one power unit to fleets of up to 200 power
units. Our Heath XS Operating Unit markets its products through 105 wholesale
brokers in all 50 states.
Our
Personal Lines Operating Unit offers non-standard personal automobile policies
which generally provide the minimum limits of liability coverage mandated by
state law to drivers who find it difficult to obtain insurance from standard
carriers due to various factors including age, driving record, claims history or
limited financial resources. Our Personal Lines Operating Unit also
provides personal products complementary to non-standard personal automobile
such as low value dwelling/homeowners, renters and motorcycle policies. Our
Personal Lines Operating Unit markets these policies through 2,054 independent
retail agents in 17 states.
Our
insurance company subsidiaries are American Hallmark Insurance Company of Texas
(“AHIC”), Hallmark Insurance Company (“HIC”) (formerly known as Phoenix
Indemnity Insurance Company) and Hallmark Specialty Insurance Company (“HSIC”).
Our insurance company subsidiaries have entered into a pooling arrangement,
pursuant to which AHIC retains 46.0% of the net premiums written, HIC retains
34.1% of the net premiums written and HSIC retains 19.9% of the net premiums
written. A.M. Best Company (“A.M. Best”),
a nationally recognized
insurance industry rating service and publisher, has
pooled its ratings
of our three insurance company subsidiaries and assigned a financial strength
rating of “A–” (Excellent) and an issuer credit rating of “a-” to each of our
individual insurance company subsidiaries and to the pool formed by our
insurance company subsidiaries.
Our five
operating units are segregated into three reportable industry segments for
financial accounting purposes. The Standard Commercial Segment
presently consists solely of the AHIS Operating Unit and the Personal Segment
presently consists solely of our Personal Lines Operating Unit. The
Specialty Commercial Segment includes our TGA Operating Unit, Aerospace
Operating Unit, and Heath XS Operating Unit. The following table
displays the gross premiums produced by these reportable segments for affiliated
and unaffiliated insurers for the years ended December 31, 2008, 2007 and 2006,
as well as the gross premiums written and net premiums written by our insurance
subsidiaries for these reportable segments for the same periods.
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Year Ended December 31,
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2008
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2007
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2006
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(dollars
in thousands)
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Gross
Premiums Produced:
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Standard
Commercial Segment
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$ | 80,193 | $ | 90,985 | $ | 91,679 | ||||||
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Specialty
Commercial Segment (1)
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146,054 | 151,003 | 156,490 | |||||||||
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Personal
Segment
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60,834 | 55,916 | 45,135 | |||||||||
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Total
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$ | 287,081 | $ | 297,904 | $ | 293,304 | ||||||
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Gross
Premiums Written:
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Standard
Commercial Segment
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$ | 80,190 | $ | 90,868 | $ | 91,070 | ||||||
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Specialty
Commercial Segment (1)
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102,825 | 102,688 | 77,740 | |||||||||
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Personal
Segment
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60,834 | 55,916 | 45,135 | |||||||||
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Total
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$ | 243,849 | $ | 249,472 | $ | 213,945 | ||||||
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Net
Premiums Written:
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Standard
Commercial Segment
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$ | 75,361 | $ | 84,595 | $ | 82,220 | ||||||
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Specialty
Commercial Segment (1)
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98,732 | 98,300 | 75,573 | |||||||||
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Personal
Segment
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60,834 | 55,916 | 45,135 | |||||||||
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Total
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$ | 234,927 | $ | 238,811 | $ | 202,928 | ||||||
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1
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The
Heath XS Operating Unit included in the Specialty Commercial Segment was
acquired effective August 29, 2008 and, therefore, is not included in the
years ended December 31, 2007 and
2006.
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Operational
Structure
Our
insurance company subsidiaries retain a portion of the premiums produced by our
operating units. The following chart reflects the operational structure of our
organization, the subsidiaries comprising our operating units and the operating
units included in each reportable segment as of December 31, 2008.
Standard
Commercial Segment / AHIS Operating Unit
The
Standard Commercial Segment of our business presently consists solely of our
AHIS Operating Unit. Our AHIS Operating Unit markets, underwrites and
services standard commercial lines insurance primarily in the non-urban areas of
Texas, New Mexico, Idaho, Oregon, Montana, Washington, Utah, and
Wyoming. The subsidiaries comprising our AHIS Operating Unit include
American Hallmark Insurance Services, a regional managing general agency, and
ECM, a claims administration company. American Hallmark Insurance
Services targets customers that are in low-severity classifications in the
standard commercial market, which as a group have relatively stable loss
results. The typical customer is a small- to medium-sized business
with a policy that covers property, general liability and automobile
exposures. Our AHIS Operating Unit underwriting criteria exclude
lines of business and classes of risks that are considered to be high-severity
or volatile, or which involve significant latent injury potential or other
long-tailed liability exposures. ECM administers the claims on the
insurance policies produced by American Hallmark Insurance
Services. Products offered by our AHIS Operating Unit include the
following:
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Commercial
automobile.
Commercial automobile insurance
provides
third-party bodily injury and property damage coverage and first-party
property damage coverage against losses resulting from the ownership,
maintenance or use of automobiles and trucks in connection with an
insured’s business.
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General
liability.
General liability insurance provides coverage for
third-party bodily injury and property damage claims arising from
accidents occurring on the insured’s premises or from their general
business operations.
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Umbrella.
Umbrella insurance provides coverage for third-party liability
claims where the loss amount exceeds coverage limits provided by the
insured’s underlying general liability and commercial automobile
policies.
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Commercial
property.
Commercial property insurance provides first-party
coverage for the insured’s real property, business personal property, and
business interruption losses caused by fire, wind, hail, water damage,
theft, vandalism and other insured
perils.
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Commercial
multi-peril.
Commercial multi-peril insurance provides a
combination of property and liability coverage that can include commercial
automobile coverage on a single
policy.
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Business
owner’s.
Business owner’s insurance
provides
a package of coverage designed for small- to medium-sized businesses with
homogeneous risk profiles. Coverage includes general liability,
commercial property and commercial
automobile.
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Our AHIS
Operating Unit markets its property/casualty insurance products through
approximately 230 independent agencies operating in its target
markets. Our AHIS Operating Unit applies a strict agent selection
process and seeks to provide its independent agents some degree of
non-contractual geographic exclusivity. Our AHIS Operating Unit also
strives to provide its independent agents with convenient access to product
information and personalized service. As a result, the Standard
Commercial Segment has historically maintained excellent relationships with its
producing agents, as evidenced by the 19-year average tenure of the 24 agency
groups which each produced more than $1.0 million in premium during the year
ended December 31, 2008. During 2008, the top ten agency groups
produced approximately 39%, and no individual agency group produced more than
7%, of the total premium volume of our AHIS Operating Unit.
Our AHIS
Operating Unit writes most risks on a package basis using a commercial
multi-peril policy or a business owner’s policy. Umbrella policies
are written only when our AHIS Operating Unit also writes the insured’s
underlying general liability and commercial automobile coverage. Through
December 31, 2005, our AHIS Operating Unit marketed policies on behalf of
Clarendon National Insurance Company (“Clarendon”), a third-party
insurer. Our AHIS Operating Unit earns a commission based on a
percentage of the earned premium it produced for Clarendon. The
commission percentage is determined by the underwriting results of the policies
produced. ECM receives a claim servicing fee based on a percentage of
the earned premium produced, with a portion deferred for casualty
claims. On July 1, 2005, our AHIS Operating Unit began marketing new
policies for AHIC and presently markets all new and renewal policies exclusively
for AHIC.
All of
the commercial policies written by our AHIS Operating Unit are for a term of 12
months. If the insured is unable or unwilling to pay for the entire
premium in advance, we provide an installment payment plan that allows the
insured to pay 20% down and the remaining payments over eight
months. We charge a flat $7.50 installment fee per payment for the
installment payment plan.
Specialty
Commercial Segment
The
Specialty Commercial Segment of our business includes our TGA Operating Unit,
our Aerospace Operating Unit, and our Heath XS Operating Unit. All of
the subsidiaries comprising our TGA Operating Unit and our Aerospace Operating
Unit were acquired effective January 1, 2006. The subsidiaries
comprising our Heath XS Operating Unit were acquired effective August 29,
2008. During 2008, our TGA Operating Unit accounted for approximately
74% of the aggregate premiums produced by the Specialty Commercial Segment, with
our Aerospace Operating Unit and Heath XS Operating Unit accounting for 17% and
9%, respectively.
TGA Operating
Unit.
Our TGA Operating Unit markets, underwrites, finances
and services commercial lines insurance in Texas, Louisiana, Arkansas, Oklahoma,
and Oregon with a particular emphasis on commercial automobile, general
liability and commercial property risks produced on an excess and surplus lines
basis. Excess and surplus lines insurance provides coverage for
difficult to place risks that do not fit the underwriting criteria of insurers
operating in the standard market. Our TGA Operating Unit also
markets, underwrites and services certain non-strategic legacy personal lines
insurance products in Texas, including dwelling fire and homeowners coverages.
The subsidiaries comprising our TGA Operating Unit include TGA, which is a
regional managing general agency, TGASRI and PAAC, which provides premium
financing for policies marketed by TGA and certain unaffiliated general and
retail agents. TGA accounts for approximately 95% of the premium volume financed
by PAAC.
Our TGA
Operating Unit focuses on small- to medium-sized commercial businesses that do
not meet the underwriting requirements of traditional standard insurers due to
issues such as loss history, number of years in business, minimum premium size
and types of business operation. During 2008, commercial automobile,
general liability and commercial property insurance accounted for approximately
97% of the premiums produced by our TGA Operating Unit. Target risks
for commercial automobile insurance are small- to medium-sized businesses with
ten or fewer vehicles which include artisan contractors, local light- to
medium-service vehicles and retail delivery vehicles. Target risks for general
liability insurance are small business risk exposures including artisan
contractors, sales and service organizations, and building and premiums
exposures. Target risks for commercial property insurance are low- to
mid-value structures including office buildings, mercantile shops, restaurants
and rental dwellings, in each case with aggregate property limits of less than
$500,000. The commercial insurance products offered by our TGA
Operating Unit include the following:
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Commercial
automobile.
Commercial automobile insurance provides third-party
bodily injury and property damage coverage and first-party property damage
coverage against losses resulting from the ownership, maintenance or use
of automobiles and trucks in connection with an insured’s
business.
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General
liability.
General liability insurance provides coverage for
third-party bodily injury and property damage claims arising from
accidents occurring on the insured’s premises or from their general
business operations.
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Commercial
property.
Commercial property insurance
provides
first-party coverage for the insured’s real property, business personal
property, theft and business interruption losses caused by fire, wind,
hail, water damage, vandalism and other insured perils.
Windstorm, hurricane and hail are generally excluded in coastal
areas.
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Our TGA
Operating Unit produces business through a network of 39 general agents with 60
offices in five states, as well as through 768 retail
agents. Our TGA Operating Unit strives to simplify the
placement of its excess and surplus lines policies by providing prompt quotes
and signature-ready applications to its independent agents. During 2008, general
agents accounted for approximately 78% of total premiums produced by our TGA
Operating Unit, with the remaining 22% being produced by retail
agents. During 2008, the top ten general agents produced
approximately 50%, and no general agent produced more than 10%, of the total
premium volume of our TGA Operating Unit. During the same period, the
top ten retail agents produced approximately 4%, and no retail agent produced
more than 1%, of the total premium volume of our TGA Operating
Unit.
Through
2008, all business of our TGA Operating Unit was produced under a fronting
agreement with member companies of the Republic Group (“Republic”) which granted
our TGA Operating Unit the authority to develop underwriting programs, set
rates, appoint retail and general agents, underwrite risks, issue policies and
adjust and pay claims. During 2006, 2007, and 2008, AHIC assumed 50%,
60%, and 70%, respectively, of the premium written under this fronting agreement
pursuant to a reinsurance agreement with Republic which expires on December 31,
2009. During 2009, Republic will continue to front certain Texas
commercial auto coverages, but AHIC will retain 100% of the written premium
produced. Commission revenue is generated under the fronting
agreement on the portion of premiums not assumed by AHIC. An
additional commission may be earned if certain loss ratio targets are met.
Additional revenue is generated from fully earned policy fees and installment
billing fees charged on the legacy personal lines products.
The
majority of the commercial policies written by our TGA Operating Unit are for a
term of 12 months. Exceptions include a few commercial automobile
policies that are written for a term that coincides with the annual harvest of
crops and special event general liability policies that are written for the term
of the event, which is generally one to two days. Commercial lines
policies are paid in full up front or financed with various premium finance
companies, including PAAC.
Aerospace
Operating Unit.
Our Aerospace Operating Unit markets,
underwrites and services general aviation property/casualty insurance in 48
states. The subsidiaries comprising our Aerospace Operating Unit
include Aerospace Insurance Managers, which markets standard aviation coverages,
ASRI, which markets excess and surplus lines aviation coverages, and ACMG, which
handles claims management. Aerospace Insurance Managers is one of
only a few similar entities in the U.S. and has focused on developing a
well-defined niche centering on transitional pilots, older aircraft and small
airports and aviation-related businesses. Products offered by our
Aerospace Operating Unit include the following:
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Aircraft.
Aircraft insurance provides third-party bodily injury and property
damage coverage and first-party hull damage coverage against losses
resulting from the ownership, maintenance or use of
aircraft.
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Airport
liability.
Airport liability insurance provides coverage for
third-party bodily injury and property damage claims arising from
accidents occurring on airport premises or from their
operations.
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Our
Aerospace Operating Unit generates its business through approximately 200
aviation specialty brokers. These specialty brokers submit to
Aerospace Insurance Managers requests for aviation insurance quotations received
from the states in which we operate and our Aerospace Operating Unit selectively
determine the risks fitting its target niche for which it will prepare a
quote. During 2008, the top ten independent specialty brokers
produced approximately 31%, and no broker produced more than 6%, of the total
premium volume of our Aerospace Operating Unit.
Our
Aerospace Operating Unit independently develops, underwrites and prices each
coverage written. We target pilots who may lack experience in the
type of aircraft they have acquired or are transitioning between types of
aircraft. We also target pilots who may be over the age limits of
other insurers. We do not accept aircraft that are used for hazardous
purposes such as crop dusting or heli-skiing. Liability limits are
controlled, with approximately 93% of the aircraft written in 2008 bearing
per-occurrence limits of $1,000,000 and per-passenger limits of $100,000 or
less. The average insured aircraft hull value for aircraft written in
2008 was approximately $145,000.
Prior to
July 1, 2006, our Aerospace Operating Unit produced policies for American
National Property & Casualty Insurance Company (“ANPAC”) under a reinsurance
program which ceded 100% of the business to several reinsurers. Under
this arrangement, revenue was generated primarily from commissions based on
written premiums net of cancellations and endorsement return premiums. An
additional commission may be earned based upon the profitability of the business
to the reinsurers. Beginning July 1, 2006, we began issuing general
aviation policies through our insurance companies and currently 40 of the 48
states are written through our insurance companies with the remaining eight
states written under a fronting arrangement with ANPAC and reinsured by
AHIC.
Heath XS
Operating Unit.
Our Heath XS Operating
Unit offers small and middle market excess commercial transportation and
commercial umbrella risks on both an admitted and non-admitted basis focusing
exclusively on trucking, specialty automobile, and non-fleet automobile
coverage. Typical risks range from one power unit to fleets of up to 200 power
units. Our Heath XS Operating Unit markets its products through 105 wholesale
brokers in all 50 states. During 2008, excess commercial automobile
accounted for 95.5% of the premiums produced by our Heath XS Operating Unit,
with the remaining 4.5% coming from commercial umbrella risks. The
commercial insurance products offered by our Heath XS Operating Unit include the
following:
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Excess
commercial automobile
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Liability
insurance designed to provide an extra layer of protection for bodily
injury, personal and advertising injury, or property damage losses above
the primary layer of automobile, general liability and employers liability
insurance. The excess insurance does not begin until the limits
of liability in the primary layer have been exhausted. The
excess layer provides not only higher limits, but catastrophic protection
for large losses.
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Excess
commercial umbrella risks.
Liability
insurance protecting businesses for bodily injury, personal and
advertising injury, or property damage claims in excess of the limits of
their primary commercial automobile, general liability and employers
liability policies, and for some claims excluded by their primary
policies (subject to a deductible). Umbrella
liability provides not only higher limits, but catastrophic protection for
large losses.
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All
business of our Heath XS Operating Unit is currently produced under an agency
agreement with The ACE Companies (“ACE”) which grants our Heath XS Operating
Unit the authority to develop underwriting programs, set rates, appoint
wholesale brokers, and underwrite risks. Effective November 1, 2008,
under a quota share reinsurance agreement with ACE, AHIC assumes 35% of the
premiums written by our Heath XS Operating Unit.
Personal
Segment / Personal Lines Operating Unit
The
Personal Segment of our business presently consists solely of our Personal Lines
Operating Unit. Our Personal Lines Operating Unit markets and
services non-standard personal automobile policies and low value
dwelling/homeowners, renters and motorcycle coverage in 17 states. We
conduct this business under the name Hallmark Insurance Company. Hallmark
Insurance Company provides management, policy and claims administration services
to HIC and includes the operations of American Hallmark General Agency, Inc. and
Hallmark Claims Services, Inc. Our non-standard personal automobile insurance
generally provides for the minimum limits of liability coverage mandated by
state laws to drivers who find it difficult to purchase automobile insurance
from standard carriers as a result of various factors, including driving record,
vehicle, age, claims history, or limited financial
resources. Products offered by our Personal Lines Operating Unit
include the following:
|
|
l
|
Personal
automobile liability.
Personal automobile liability insurance
provides coverage primarily at the minimum limits required by law for
automobile liability exposures, including bodily injury and property
damage, arising from accidents involving the
insured.
|
|
|
l
|
Personal
automobile physical damage.
Personal automobile physical damage
insurance provides collision and comprehensive coverage for physical
damage exposure to the insured vehicle as a result of an accident with
another vehicle or object or as a result of causes other than collision
such as vandalism, theft, wind, hail or
water.
|
|
|
l
|
Low value
dwelling/homeowners.
Low value dwelling/homeowners
insurance provides coverage against insured’s property being destroyed or
damaged by various perils and coverage for liability exposure of the
insured.
|
|
|
l
|
Renters.
Renters
insurance provides coverage for the contents of a renter’s home or
apartment and for liability. Renter’s policies are similar to
homeowners insurance, except they do not cover the
structure.
|
|
|
l
|
Motorcycle.
Motorcycle insurance provides coverage similar to the personal
automobile products. A motorcycle policy is generally utilized
for vehicles that do not qualify for a personal automobile policy because
they have fewer than four wheels. Passenger liability may be
included or excluded depending on customer choice or regulatory
requirements.
|
Our
Personal Lines Operating Unit markets its non-standard personal automobile
policies through 2,054 independent agents operating in its target geographic
markets. Subject to certain criteria, our Personal Lines Operating
Unit seeks to maximize the number of agents appointed in each geographic area in
order to more effectively penetrate its highly competitive markets. However, our
Personal Lines Operating Unit periodically evaluates its independent agents and
discontinues the appointment of agents whose production history does not satisfy
certain standards. During 2008, the top ten independent agency groups produced
approximately 14%, and no individual agency group produced more than 3%, of the
total premium volume of our Personal Lines Operating Unit.
During
2008, personal automobile liability coverage accounted for approximately 75% and
personal automobile physical damage coverage accounted for the remaining 25% of
the total premiums produced by our Personal Lines Operating
Unit. American Hallmark General Agency, Inc. currently offers one-,
two-, three-, six- and twelve-month policies. Our typical
non-standard personal automobile customer is unable or unwilling to pay a full
or half year's premium in advance. Accordingly, we currently offer a
direct bill program where the premiums are directly billed to the insured on a
monthly basis. We charge installment fees for each payment under the
direct bill program.
Our
Personal Lines Operating Unit markets non-standard personal automobile, low
value/dwelling homeowners, renters and motorcycle policies in 17 states directly
for HIC. In Texas, our Personal Lines Operating Unit markets its
policies both through reinsurance arrangements with unaffiliated companies and,
since the fourth quarter of 2005, directly for HIC. We provide non-standard
personal automobile coverage in Texas through a reinsurance arrangement with Old
American County Mutual Fire Insurance Company (“OACM”). American
Hallmark General Agency, Inc. holds a managing general agency appointment from
OACM to manage the sale and servicing of OACM policies. HIC reinsures
100% of the OACM policies produced by American Hallmark General Agency, Inc.
under these reinsurance arrangements.
Our
Competitive Strengths
We
believe that we enjoy the following competitive strengths:
|
|
·
|
Specialized
market knowledge and underwriting expertise.
All of our
operating units possess extensive knowledge of the specialty and niche
markets in which they operate, which we believe allows them to effectively
structure and market their property/casualty insurance
products. Our Personal Lines Operating Unit has a thorough
understanding of the unique characteristics of the non-standard personal
automobile market. Our AHIS Operating Unit has significant underwriting
experience in its target markets for standard commercial property/casualty
insurance products. In addition, our TGA Operating Unit,
Aerospace Operating Unit, and Heath XS Operating Unit have developed
specialized underwriting expertise which enhances their ability to
profitably underwrite non-standard property/casualty insurance
coverages.
|
|
|
·
|
Tailored
market strategies.
Each of our operating units has developed its
own customized strategy for penetrating the specialty or niche markets in
which it operates. These strategies include distinctive product
structuring, marketing, distribution, underwriting and servicing
approaches by each operating unit. As a result, we are able to
structure our property/casualty insurance products to serve the unique
risk and coverage needs of our insureds. We believe that these
market-specific strategies enable us to provide policies tailored to the
target customer which are appropriately priced and fit our risk
profile.
|
|
|
·
|
Superior
agent and customer service.
We believe that performing the
underwriting, billing, customer service and claims management functions at
the operating unit level allows us to provide superior service to both our
independent agents and insured customers. The easy-to-use
interfaces and responsiveness of our operating units enhance their
relationships with the independent agents who sell our
policies. We also believe that our consistency in offering our
insurance products through hard and soft markets helps to build and
maintain the loyalty of our independent agents. Our customized products,
flexible payment plans and prompt claims processing are similarly
beneficial to our insureds.
|
|
|
·
|
Market
diversification.
We believe that operating in various
specialty and niche segments of the property/casualty insurance market
diversifies both our revenues and our risks. We also believe
our operating units generally operate on different market cycles,
producing more earnings stability than if we focused entirely on one
product. As a result of the pooling arrangement among our insurance
company subsidiaries, we are able to efficiently allocate our capital
among these various specialty and niche markets in response to market
conditions and expansion opportunities. We believe that this
market diversification reduces our risk profile and enhances our
profitability.
|
|
|
·
|
Experienced
management team.
Our senior corporate management has an
average of over 20 years of insurance experience. In addition,
our operating units have strong management teams, with an average of more
than 25 years of insurance industry experience for the heads of our
operating units and an average of more than 15 years of underwriting
experience for our underwriters. Our management has significant
experience in all aspects of property/casualty insurance, including
underwriting, claims management, actuarial analysis, reinsurance and
regulatory compliance. In addition, Hallmark’s senior
management has a strong track record of acquiring businesses that expand
our product offerings and improve our profitability
profile.
|
Our
Strategy
We are
striving to become a leading diversified property/casualty insurance group
offering products in specialty and niche markets through the following
strategies:
|
|
·
|
Focusing on
underwriting discipline and operational efficiency.
We
seek to consistently generate an underwriting profit on the business we
write in hard and soft markets. Our operating units have a
strong track record of underwriting discipline and operational efficiency
which we seek to continue. We believe that in soft markets our
competitors often offer policies at a low or negative underwriting profit
in order to maintain or increase their premium volume and market
share. In contrast, we seek to write business based on its
profitability rather than focusing solely on premium
production. To that end, we provide financial incentives to
many of our underwriters and independent agents based on underwriting
profitability.
|
|
|
·
|
Increasing
the retention of business written by our operating
units.
Our operating units have a strong track record of
writing profitable business in their target
markets. Historically, the majority of those premiums were
retained by unaffiliated insurers. During 2005, we increased
the capital of our insurance company subsidiaries which has enabled us to
retain significantly more of the premiums our operating units
produce. We expect to continue to increase the portion of our
premium production retained by our insurance company
subsidiaries. We believe that the underwriting profit earned
from this retained business will drive our profitability growth in the
near-term.
|
|
|
·
|
Achieving
organic growth in our existing business lines.
We
believe that we can achieve organic growth in our existing business lines
by consistently providing our insurance products through market cycles,
expanding geographically, expanding our product offerings, expanding our
agency relationships and further penetrating our existing customer
base. We believe that our extensive market knowledge and strong
agency relationships position us to compete effectively in our various
specialty and niche markets. We also believe there is a
significant opportunity to expand some of our existing business lines into
new geographical areas and through new agency relationships while
maintaining our underwriting discipline and operational
efficiency. In addition, we believe there is an opportunity for
some of our operating units to further penetrate their existing customer
bases with additional products offered by other operating
units.
|
|
|
·
|
Pursuing
selected, opportunistic acquisitions.
We seek to
opportunistically acquire insurance organizations that operate in
specialty or niche property/casualty insurance markets that are
complementary to our existing operations. We seek to acquire
companies with experienced management teams, stable loss results and
strong track records of underwriting profitability and operational
efficiency. Where appropriate, we intend to ultimately retain
profitable business produced by the acquired companies that would
otherwise be retained by unaffiliated insurers. Our management
has significant experience in evaluating potential acquisition targets,
structuring transactions to ensure continued success and integrating
acquired companies into our operational
structure.
|
Distribution
We market
our property/casualty insurance products solely through independent general
agents, retail agents and specialty brokers. Therefore, our
relationships with independent agents and brokers are critical to our ability to
identify, attract and retain profitable business. Each of our
operating units has developed its own tailored approach to establishing and
maintaining its relationships with these independent distributors of our
products. These strategies focus on providing excellent service to
our agents and brokers, maintaining a consistent presence in our target niche
and specialty markets through hard and soft market cycles and fairly
compensating the agents and brokers who market our products. Our
operating units also regularly evaluate independent general and retail agents
based on the underwriting profitability of the business they produce and their
performance in relation to our objectives.
Except
for the products of our Aerospace Operating Unit and our Heath XS Operating
Unit, the distribution of property/casualty insurance products by our business
segments is geographically concentrated. For the twelve months ended
December 31, 2008, five states accounted for approximately 75% of the gross
premiums retained by our insurance subsidiaries. The following table
reflects the geographic distribution of our insured risks, as represented by
direct and assumed premiums written by our business segments for the twelve
months ended December 31, 2008.
|
Standard
|
Specialty
|
|||||||||||||||||||
|
Commercial
|
Commercial
|
Personal
|
Percent of
|
|||||||||||||||||
|
State
|
Segment
|
Segment
|
Segment
|
Total
|
Total
|
|||||||||||||||
|
(dollars
in thousands)
|
||||||||||||||||||||
|
Texas
|
$ | 23,004 | $ | 71,139 | $ | 13,375 | $ | 107,518 | 44.1 | % | ||||||||||
|
Oregon
|
24,319 | 384 | 1,413 | 26,116 | 10.7 | % | ||||||||||||||
|
New
Mexico
|
12,856 | 472 | 9,089 | 22,417 | 9.2 | % | ||||||||||||||
|
Idaho
|
11,574 | 333 | 1,803 | 13,710 | 5.6 | % | ||||||||||||||
|
Arizona
|
- | 861 | 12,810 | 13,671 | 5.6 | % | ||||||||||||||
|
All
other states
|
8,437 | 29,636 | 22,344 | 60,417 | 24.8 | % | ||||||||||||||
|
Total
gross premiums written
|
$ | 80,190 | $ | 102,825 | $ | 60,834 | $ | 243,849 | ||||||||||||
|
Percent
of total
|
32.9 | % | 42.2 | % | 24.9 | % | 100.0 | % | ||||||||||||
Underwriting
The
underwriting process employed by our operating units involves securing an
adequate level of underwriting information, identifying and evaluating risk
exposures and then pricing the risks we choose to accept. Each of our
operating units offering commercial or aviation insurance products employs its
own underwriters with in-depth knowledge of the specific niche and specialty
markets targeted by that operating unit. We employ a disciplined
underwriting approach that seeks to provide policies appropriately tailored to
the specified risks and to adopt price structures that will be supported in the
applicable market. Our experienced commercial and aviation underwriters have
developed underwriting principles and processes appropriate to the coverages
offered by their respective operating units.
We
believe that managing the underwriting process through our operating units
capitalizes on the knowledge and expertise of their personnel in specific
markets and results in better underwriting decisions. All of our
underwriters have established limits of underwriting authority based on their
level of experience. We also provide financial incentives to many of
our underwriters based on underwriting profitability.
To better
diversify our revenue sources and manage our risk, we seek to maintain an
appropriate business mix among our operating units. At the beginning of each
year, we establish a target net loss ratio for each operating unit. We then
monitor the actual net loss ratio on a monthly basis. If any line of business
fails to meet its target net loss ratio, we seek input from our underwriting,
actuarial and claims management personnel to develop a corrective action
plan. Depending on the particular circumstances, that plan may
involve tightening underwriting guidelines, increasing rates, modifying product
structure, re-evaluating independent agency relationships or discontinuing
unprofitable coverages or classes of risk.
An
insurance company's underwriting performance is traditionally measured by its
statutory loss and loss adjustment expense ratio, its statutory expense ratio
and its statutory combined ratio. The statutory loss and loss
adjustment expense ratio, which is calculated as the ratio of net losses and
loss adjustment expenses (“LAE”) incurred to net premiums earned, helps to
assess the adequacy of the insurer’s rates, the propriety of its underwriting
guidelines and the performance of its claims department. The
statutory expense ratio, which is calculated as the ratio of underwriting and
operating expenses to net premiums written, assists in measuring the insurer’s
cost of processing and managing the business. The statutory combined
ratio, which is the sum of the statutory loss and LAE ratio and the statutory
expense ratio, is indicative of the overall profitability of an insurer’s
underwriting activities, with a combined ratio of less than 100% indicating
profitable underwriting results.
The
following table shows, for the periods indicated, (i) our gross premiums written
(in thousands); and (ii) our underwriting results as measured by the net
statutory loss and LAE ratio, the statutory expense ratio, and the statutory
combined ratio.
|
Year
Ended December 31,
|
||||||||||||
|
2008
|
2007
|
2006
|
||||||||||
|
Gross
premiums written
|
$ | 243,849 | $ | 249,472 | $ | 213,945 | ||||||
|
Statutory
loss & LAE ratio
|
63.4 | % | 61.5 | % | 61.5 | % | ||||||
|
Statutory
expense ratio
|
30.9 | % | 30.0 | % | 29.4 | % | ||||||
|
Statutory
combined ratio
|
94.3 | % | 91.5 | % | 90.9 | % | ||||||
These
statutory ratios do not reflect the deferral of policy acquisition costs,
investment income, premium finance revenues, or the elimination of inter-company
transactions required by U.S. generally accepted accounting principles
(“GAAP”).
The
premium-to-surplus percentage measures the relationship between net premiums
written in a given period (premiums written, less returned premiums and
reinsurance ceded to other carriers) to policyholders surplus (admitted assets
less liabilities), determined on the basis of statutory accounting practices
prescribed or permitted by insurance regulatory
authorities. Insurance companies are expected to maintain a
premium-to-surplus percentage of not more than 300%. For the years ended
December 31, 2008, 2007, and 2006, our consolidated premium-to-surplus ratios
were 170%, 181% and 181%, respectively. The decrease in
premium-to-surplus percentage in 2008 reflects lower net written premiums by the
Standard Commercial Segment offset by additional retention of premiums produced
by the Specialty Commercial Segment, as well as increased premiums written in
the Personal Segment.
Claims
Management and Administration
We
believe that effective claims management is critical to our success and that our
claims management process is cost-effective, delivers the appropriate level of
claims service and produces superior claims results. Our claims management
philosophy emphasizes the delivery of courteous, prompt and effective claims
handling and embraces responsiveness to policyholders and agents. Our
claims strategy focuses on thorough investigation, timely evaluation and fair
settlement of covered claims while consistently maintaining appropriate case
reserves. We seek to compress the cycle time of claim resolution in order to
control both loss and claim handling cost. We also strive to control
legal expenses by negotiating competitive rates with defense counsel and
vendors, establishing litigation budgets and monitoring invoices.
Each of
our operating units maintains its own dedicated staff of specialized claims
personnel to manage and administer claims arising under policies produced
through their respective operations. The claims process is managed
through a combination of experienced claims managers, seasoned claims
supervisors, trained staff adjusters and independent adjustment or appraisal
services, when appropriate. All adjusters are licensed in those jurisdictions
for which they handle claims that require licensing. Limits on settlement
authority are established for each claims supervisor and staff adjuster based on
their level of experience. Independent adjusters have no claim
settlement authority. Claim exposures are periodically and
systematically reviewed by claim supervisors and managers as a method of quality
and loss control. Large loss exposures are reviewed at least
quarterly with senior management of the operating unit and monitored by Hallmark
senior management.
Claims
personnel receive in-house training and are required to attend various
continuing education courses pertaining to topics such as best practices, fraud
awareness, legal environment, legislative changes and litigation management.
Depending on the criteria of each operating unit, our claims adjusters are
assigned a variety of claims to enhance their knowledge and ensure their
continued development in efficiently handling claims. As of December 31, 2008,
our operating units had a total of 50 claims managers, supervisors and adjusters
with an average of approximately 16 years experience.
Analysis
of Losses and LAE
Our
consolidated financial statements include an estimated reserve for unpaid losses
and LAE. We estimate our reserve for unpaid losses and LAE by using
case-basis evaluations and statistical projections, which include inferences
from both losses paid and losses incurred. We also use recent
historical cost data and periodic reviews of underwriting standards and claims
management practices to modify the statistical projections. We give
consideration to the impact of inflation in determining our loss reserves, but
do not discount reserve balances.
The
amount of reserves represents our estimate of the ultimate cost of all unpaid
losses and LAE incurred. These estimates are subject to the effect of
trends in claim severity and frequency. We regularly review the estimates and
adjust them as claims experience develops and new information becomes
known. Such adjustments are included in current operations, including
increases and decreases, net of reinsurance, in the estimate of ultimate
liabilities for insured events of prior years.
Changes
in loss development patterns and claim payments can significantly affect the
ability of insurers to estimate reserves for unpaid losses and related
expenses. We seek to continually improve our loss estimation process
by refining our ability to analyze loss development patterns, claim payments and
other information within a legal and regulatory environment which affects
development of ultimate liabilities. Future changes in estimates of claim costs
may adversely affect future period operating results. However, such
effects cannot be reasonably estimated currently.
Reconciliation of
reserve for unpaid losses and LAE
.
The following
table provides a reconciliation of our beginning and ending reserve balances on
a net-of-reinsurance basis for the years ended December 31, 2008, 2007 and 2006,
to the gross-of-reinsurance amounts reported in our balance sheets at December
31, 2008, 2007 and 2006.
|
As
of and for Year Ended December 31,
|
||||||||||||
|
2008
|
2007
|
2006
|
||||||||||
|
(dollars
in thousands)
|
||||||||||||
|
Reserve
for unpaid losses and LAE, net of reinsurance recoverables, January
1
|
$ | 120,849 | $ | 72,801 | $ | 25,997 | ||||||
|
Acquisitions
of subsidiaries effective January 1
|
- | - | 4,562 | |||||||||
|
Provision
for losses and LAE for claims occurring in the current
period
|
146,059 | 139,332 | 88,294 | |||||||||
|
Increase
(decrease) in reserve for unpaid losses and LAE for claims occurring in
prior periods
|
(1,815 | ) | (6,414 | ) | (1,177 | ) | ||||||
|
Payments
for losses and LAE, net of reinsurance:
|
||||||||||||
|
Current
period
|
(64,610 | ) | (54,809 | ) | (28,154 | ) | ||||||
|
Prior
periods
|
(50,458 | ) | (30,061 | ) | (16,721 | ) | ||||||
|
Reserve
for unpaid losses and LAE at December 31, net of
reinsurance recoverable
|
$ | 150,025 | $ | 120,849 | $ | 72,801 | ||||||
|
Reinsurance
recoverable on unpaid losses and LAE at December 31
|
6,338 | 4,489 | 4,763 | |||||||||
|
Reserve
for unpaid losses and LAE at December 31, gross of
reinsurance
|
$ | 156,363 | $ | 125,338 | $ | 77,564 | ||||||
The $1.8
million, $6.4 million and $1.2 million favorable development in prior accident
years recognized in 2008, 2007 and 2006, respectively, represent normal changes
in our loss reserve estimates. In each case, the aggregate loss reserve
estimates for prior years were decreased to reflect favorable loss development
when the available information indicated a reasonable likelihood that the
ultimate losses would be less than the previous estimates. Generally, changes in
reserves are caused by variations between actual experience and previous
expectations and by reduced emphasis on the Bornhuetter-Ferguson method due to
the aging of the accident years. (See, “Item 7. Management’s
Discussion and Analysis of Financial Condition and Results of Operations -
Critical Accounting Estimates and Judgments - Reserves for unpaid losses and
loss adjustment expenses.”)
The $1.8
million decrease in reserves for unpaid losses and LAE recognized in 2008 was
attributable to $0.7 million favorable development on claims incurred in the
2007 accident year, $0.9 million favorable development on claims incurred in the
2006 accident year and $0.2 million favorable development on claims incurred in
the 2005 and prior accident years. Our AHIS Operating Unit and
Personal Lines Operating Unit accounted for $2.4 million and $0.7 million,
respectively, of the decrease in reserves recognized in 2008, partially offset
by a $1.5 million increase in reserves in our TGA Operating
Unit. The decrease in reserves for our AHIS Operating Unit was
primarily the result of favorable claims development in the 2007 accident year
with respect to the commercial automobile physical damage and commercial
property lines of business, offset somewhat by unfavorable development in
accident year 2005 with respect to commercial package liability
coverage. The decrease in reserves for our Personal Lines Operating
Unit was primarily the result of favorable claims development in accident year
2006. The increase in reserves for our TGA Operating Unit was
primarily the result of unfavorable claims development in accident years 2006
and 2007 attributable to a small number of larger than normal commercial
automobile liability claims, partially offset by favorable claims development on
the general liability line of business in accident years 2005 through
2007.
The $6.4
million decrease in reserves for unpaid losses and LAE recognized in 2007 was
attributable to $3.2 million favorable development on claims incurred in the
2006 accident year, $1.8 million favorable development on claims incurred in the
2005 accident year and $1.4 million favorable development on claims incurred in
the 2004 and prior accident years. Our TGA Operating Unit and AHIS
Operating Unit accounted for $3.7 million and $1.7 million, respectively, of the
decrease in reserves for unpaid losses and LAE recognized in
2007. Loss experience data accumulated since our acquisition of the
TGA Operating Unit in January, 2006, were lower than the outside actuary’s
estimate initially used to establish loss reserves. In late 2006, our
AHIS Operating Unit experienced a small number of large, late reported general
liability losses from earlier accident years. As a result of this
unexpected claim development, we increased our loss reserve estimates for this
business at the end of 2006. However, subsequent experience suggested
that the impact of these types of claims would be less significant in more
recent accident years than originally anticipated due in part to coverage
restrictions previously implemented.
The $1.2
million decrease in reserves for unpaid losses and LAE recognized in 2006 was
primarily attributable to favorable loss development in our Personal Segment for
accident years 2002 through 2004. At the time these loss reserves
were initially established, new management was in the process of implementing
operational changes designed to improve operating results. However,
the effectiveness of these operational changes could not be accurately predicted
at that time. As additional data emerged, it became increasingly
clear that the actual results from these operational enhancements were
developing more favorably than originally projected.
SAP/GAAP reserve
reconciliation.
The differences between
the reserves for unpaid losses and LAE reported in our consolidated financial
statements prepared in accordance with GAAP and those reported in our annual
statements filed with the Texas Department of Insurance, the Arizona Department
of Insurance and the Oklahoma Insurance Department in accordance with statutory
accounting practices (“SAP”) as of December 31, 2008 and 2007 are summarized
below.
|
As
of December 31,
|
||||||||
|
2008
|
2007
|
|||||||
|
(in
thousands)
|
||||||||
|
Reserve
for unpaid losses and LAE on a SAP basis (net of reinsurance recoverables
on unpaid losses)
|
$ | 150,024 | $ | 120,798 | ||||
|
Unamortized
risk premium reserve discount from the HIC acquisition
|
- | 1 | ||||||
|
Estimated
future unallocated LAE reserve for claim service
subsidiaries
|
1 | 50 | ||||||
|
Reserve
for unpaid losses and LAE on a GAAP basis (net of reinsurance recoverables
on unpaid losses)
|
$ | 150,025 | $ | 120,849 | ||||
Analysis of loss
and LAE reserve development.
The following table
shows the development of our loss reserves, net of reinsurance, for years ended
December 31, 1998 through 2008. Section A of the table shows the
estimated liability for unpaid losses and LAE, net of reinsurance, recorded at
the balance sheet date for each of the indicated years. This
liability represents the estimated amount of losses and LAE for claims arising
in prior years that are unpaid at the balance sheet date, including losses that
have been incurred but not yet reported to us. Section B of the table
shows the re-estimated amount of the previously recorded liability, based on
experience as of the end of each succeeding year. The estimate is
increased or decreased as more information becomes known about the frequency and
severity of claims.
Cumulative
Redundancy/Deficiency (Section C of the table) represents the aggregate change
in the estimates over all prior years. Thus, changes in ultimate
development estimates are included in operations over a number of years,
minimizing the significance of such changes in any one year.
ANALYSIS
OF LOSS AND LAE DEVELOPMENT
As
of and for Year Ended December 31
|
1998
|
1999
|
2000
|
2001
|
2002
|
2003
|
2004
|
2005
|
2006
|
2007
|
2008
|
||||||||||||||||||||||||||||||||||
|
(dollars
in thousands)
|
||||||||||||||||||||||||||||||||||||||||||||
|
A.
Reserve for Unpaid Losses & LAE, Net of Reinsurance
Recoverables
|
$ | 4,580 | $ | 5,409 | $ | 7,451 | $ | 7,919 | $ | 8,411 | $ | 21,197 | $ | 17,700 | $ | 25,997 | $ | 72,801 | $ | 120,849 | $ | 150,025 | ||||||||||||||||||||||
|
B.
Net Reserve Re-estimated as of :
|
||||||||||||||||||||||||||||||||||||||||||||
|
One
year later
|
4,594 | 5,506 | 7,974 | 8,096 | 8,875 | 20,003 | 15,300 | 24,820 | 66,387 | 119,034 | ||||||||||||||||||||||||||||||||||
|
Two
years later
|
4,464 | 5,277 | 7,863 | 8,620 | 8,881 | 19,065 | 15,473 | 24,903 | 68,490 | |||||||||||||||||||||||||||||||||||
|
Three
years later
|
4,225 | 5,216 | 7,773 | 8,856 | 8,508 | 19,698 | 13,962 | 23,144 | ||||||||||||||||||||||||||||||||||||
|
Four
years later
|
4,179 | 5,095 | 7,901 | 8,860 | 8,446 | 18,551 | 14,166 | |||||||||||||||||||||||||||||||||||||
|
Five
years later
|
4,111 | 5,028 | 7,997 | 8,855 | 8,478 | 18,769 | ||||||||||||||||||||||||||||||||||||||
|
Six
years later
|
4,101 | 5,153 | 7,999 | 8,884 | 8,461 | |||||||||||||||||||||||||||||||||||||||
|
Seven
years later
|
4,209 | 5,153 | 8,026 | 8,669 | ||||||||||||||||||||||||||||||||||||||||
|
Eight
years later
|
4,203 | 5,182 | 8,014 | |||||||||||||||||||||||||||||||||||||||||
|
Nine
years later
|
4,227 | 5,170 | ||||||||||||||||||||||||||||||||||||||||||
|
Ten
years later
|
4,227 | |||||||||||||||||||||||||||||||||||||||||||
|
C.
Net Cumulative Redundancy (Deficiency)
|
353 | 239 | (563 | ) | (750 | ) | (50 | ) | 2,428 | 3,534 | 2,853 | 4,311 | 1,815 | |||||||||||||||||||||||||||||||
|
D.
Cumulative Amount of Claims Paid, Net of Reinsurance Recoveries,
through:
|
||||||||||||||||||||||||||||||||||||||||||||
|
One
year later
|
2,791 | 3,229 | 5,377 | 5,691 | 5,845 | 12,217 | 8,073 | 16,721 | 30,061 | 50,458 | ||||||||||||||||||||||||||||||||||
|
Two
years later
|
3,476 | 4,436 | 7,070 | 7,905 | 7,663 | 15,814 | 12,004 | 22,990 | 46,860 | |||||||||||||||||||||||||||||||||||
|
Three
years later
|
3,911 | 4,909 | 7,584 | 8,603 | 8,228 | 18,162 | 13,113 | 24,562 | ||||||||||||||||||||||||||||||||||||
|
Four
years later
|
4,002 | 5,014 | 7,810 | 8,798 | 8,374 | 17,997 | 13,750 | |||||||||||||||||||||||||||||||||||||
|
Five
years later
|
4,051 | 4,966 | 7,960 | 8,821 | 8,417 | 18,415 | ||||||||||||||||||||||||||||||||||||||
|
Six
years later
|
4,061 | 5,116 | 7,970 | 8,853 | 8,439 | |||||||||||||||||||||||||||||||||||||||
|
Seven
years later
|
4,204 | 5,124 | 7,995 | 8,869 | ||||||||||||||||||||||||||||||||||||||||
|
Eight
years later
|
4,203 | 5,151 | 8,014 | |||||||||||||||||||||||||||||||||||||||||
|
Nine
years later
|
4,227 | 5,170 | ||||||||||||||||||||||||||||||||||||||||||
|
Ten
years later
|
||||||||||||||||||||||||||||||||||||||||||||
|
2008
|
2007
|
|||||||
|
Net Reserve,
December 31
|
$ | 150,025 | $ | 120,849 | ||||
|
Reinsurance
Recoverables
|
6,338 | 4,489 | ||||||
|
Gross
Reserve, December 31
|
$ | 156,363 | $ | 125,338 | ||||
|
Net
Re-estimated Reserve
|
$ | 119,034 | ||||||
|
Re-estimated
Reinsurance Recoverable
|
6,007 | |||||||
|
Gross
Re-estimated Reserve
|
$ | 125,041 | ||||||
|
Gross
Cumulative Redundancy
|
$ | 297 | ||||||
Reinsurance
We
reinsure a portion of the risk we underwrite in order to control our exposure to
losses and to protect our capital resources. We cede to reinsurers a
portion of these risks and pay premiums based upon the risk and exposure of the
policies subject to such reinsurance. Ceded reinsurance involves
credit risk and is generally subject to aggregate loss
limits. Although the reinsurer is liable to us to the extent of the
reinsurance ceded, we are ultimately liable as the direct insurer on all risks
reinsured. Reinsurance recoverables are reported after allowances for
uncollectible amounts. We monitor the financial condition of
reinsurers on an ongoing basis and review our reinsurance arrangements
periodically. Reinsurers are selected based on their financial
condition, business practices and the price of their product
offerings. Our reinsurance facilities are subject to annual
renewal.
The
following table presents our gross and net premiums written and earned and
reinsurance recoveries for each of the last three years.
|
Year
Ended December 31,
|
||||||||||||
|
2008
|
2007
|
2006
|
||||||||||
|
Gross
premiums written
|
$ | 243,849 | $ | 249,472 | $ | 213,945 | ||||||
|
Ceded
premiums written
|
(8,922 | ) | (10,661 | ) | (11,017 | ) | ||||||
|
Net
premiums written
|
$ | 234,927 | $ | 238,811 | $ | 202,928 | ||||||
|
Gross
premiums earned
|
$ | 244,656 | $ | 238,080 | $ | 162,216 | ||||||
|
Ceded
premiums earned
|
(8,336 | ) | (12,109 | ) | (10,155 | ) | ||||||
|
Net
premiums earned
|
$ | 236,320 | $ | 225,971 | $ | 152,061 | ||||||